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  3. 2021
  4. Preliminary Program
  5. Monetary and Financial Policies for Open Economies
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Monetary and Financial Policies for Open Economies

Paper Session

Tuesday, Jan. 5, 2021 3:45 PM - 5:45 PM (EST)

Hosted By: American Economic Association
  • Chair: Gita Gopinath, International Monetary Fund

Integrated Monetary and Financial Policies for Small Open Economies

Suman Basu
,
International Monetary Fund
Emine Boz
,
International Monetary Fund
Gita Gopinath
,
International Monetary Fund
Francisco Roch
,
International Monetary Fund
Filiz Unsal
,
International Monetary Fund

Abstract

Many small open economies deploy foreign exchange intervention, capital controls,and macroprudential policies to cope with shocks, such as the ongoing COVID-19 shock. However, our understanding of how these tools interact with each other and with standard interest rate setting remains limited. To fill this gap, we develop a micro-founded model that characterizes the optimal joint use of these policies. Our framework incorporates nominal rigidities with producer (PCP) and dominant currency pricing (DCP), pecuniary externalities due to borrowing constraints, as well as shallow foreign exchange markets. We find that: (1) Prudential capital controls to address pecuniary externalities tend to be larger under DCP than PCP. (2) FX intervention and capital controls after foreign appetite shocks enhance monetary autonomy, when FX markets are shallow. (3) While banning open FX
exposures in shallow FX markets can reduce the need for prudential capital controls to address pecuniary externalities, the ban increases the economy’s vulnerability to foreign appetite shocks, and can make the economy more dependent on FX intervention.

Optimal Monetary Policy Under Dollar Pricing

Konstantin Egorov
,
New Economic School
Dmitry Mukhin
,
University of Wisconsin-Madison

Abstract

The recent empirical evidence shows that most international prices are sticky in dollars. This paper studies the optimal non-cooperative monetary policy and the welfare implications of dollar pricing in a context of an open economy model with nominal rigidities and input-output linkages between firms. We establish the following results: 1) dollar pricing generates asymmetric international spillovers such that other countries partially peg their exchange rates to the dollar giving rise to a “global monetary cycle”; 2) capital controls cannot insulate other countries from U.S. spillovers;
3) the U.S. finds it optimal to deviate from inflation targeting to partially stabilize global economy; 4) the optimal cooperative policy is hard to implement because it generates gains for non-U.S. countries and losses for the U.S.; 5) there are potential gains from dollar pricing for the U.S., while other countries can benefit from forming a currency union such as the Eurozone.

Exchange Rate Dynamics and Monetary Spillovers with Imperfect Financial Markets

Ozge Akinci
,
Federal Reserve Bank of New York
Albert Queralto
,
Federal Reserve Board

Abstract

Why do shifts in U.S. monetary policy trigger large cross-border spillovers, especially on emerging markets (EMs)? We propose a model featuring imperfections in domestic and international financial markets that generates strong effects of U.S. monetary policy on EM asset prices, financial conditions, currency values, and economic activity. Financial imperfections prevent arbitrage both between local EM lending and borrowing rates, and between local-currency and dollar borrowing rates: both the local lending spread and the premium on the local currency, which are typically positive, vary inversely with EM borrowers' financial health. A novel adverse feedback effect between financial health and external conditions complements and amplifies the domestic-based "financial accelerator," accounting for large spillovers of U.S. monetary policy. Our model’s implications for the effects of U.S. monetary shocks on EM GDP, as well as the model-predicted link between violations of uncovered interest parity and EM lending spreads, are consistent with the data.

Scrambling for Dollars: International Liquidity, Banks and Exchange Rates

Javier Bianchi
,
Federal Reserve Bank of Minneapolis
Saki Bigio
,
University of California-Los Angeles
Charles Engel
,
Univeristy of Wisconsin

Abstract

We develop a theory of exchange rate fluctuations arising from financial institutions' demand for liquid dollar assets. Financial flows are unpredictable and may leave banks “scrambling for dollars''. As a result of settlement frictions in interbank markets, a precautionary demand for dollar reserves emerges and gives rise to an endogenous convenience yield. In our framework, an increase in the volatility of idiosyncratic liquidity shocks leads to a rise in the convenience yield and an appreciation of the dollar---as banks scramble for dollars---while foreign exchange interventions matter because they alter the relative supply of liquidity in different currencies. We present empirical evidence on the relationship between exchange rate fluctuations for the G10 currencies and the quantity of dollar liquidity  consistent with the theory.    
Discussant(s)
Matteo Maggiori
,
Stanford University
Guido Lorenzoni
,
Northwestern University
Stephanie Schmitt-Grohé
,
Columbia University
Oleg Itskhoki
,
Princeton University
JEL Classifications
  • F4 - Macroeconomic Aspects of International Trade and Finance
  • F3 - International Finance